Ch. 17 - Ross Fuerman
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Chapter 17 Completing the Audit Engagement
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Review for Contingent Liabilities A contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future event occurs or fails to occur. Examples • Pending or threatened litigation • Actual or possible claims and assessments • Income tax disputes • Product warranties or defects • Guarantees of obligations to others
Probable: The future event is likely to occur. Reasonably Possible: The chances of the future event occurring is more than remote but less than probable. Remote: The chance of the future event occurring is slight.
Audit Procedures for Identifying Contingent Liabilities Read minutes of meetings of the board of directors, committees of the board, and stockholders.
Review contracts, loan agreements, leases, and correspondence from government agencies.
Review tax returns, IRS reports, and schedules supporting the client’s income tax liability. Confirm or otherwise document guarantees and letters of credit.
Inspect other documents for possible guarantees or other similar arrangements.
Audit Procedures for Identifying Contingent Liabilities Specific Audit Procedures Conducted Near Completion of Audit Inquire and discuss with management about its policies and procedures for identifying, evaluating, and accounting for contingent liabilities.
Examine documents in the entity’s records such as correspondence and invoices from attorneys for pending or threatened lawsuits.
Obtain a legal letter that describes and evaluates any litigation, claims, or assessments.
Obtain written representation from management that all litigation, asserted and unasserted claims, and assessments have been disclosed in accordance with FASB ASC Topic 450. 17-4
Legal Letters A letter of audit inquiry (legal letter) sent to the client’s attorneys is the primary means of obtaining or corroborating information about litigation, claims, and assessments.
Example of Legal Letter
Long-term contracts to purchase raw materials or sell their products at a fixed price
To obtain a favorable pricing arrangement
To secure the availability of raw materials
Long-term commitments are usually identified through inquiry of client personnel during the audit of the revenue and purchasing processes. In most cases, such commitments are disclosed in a footnote to the financial statements. 17-7
Review for Subsequent Events for Audit of Financial Statements Balance Sheet Date
Type I Event
Type II Event
Conditions existed before the balance sheet date and affect estimates that are part of financial statements
Conditions did not exist at the balance sheet date and do not affect the accuracy of the financial statements
Require adjustment of the financial statements
Require disclosure and possibly pro forma financial statements 17-8
Review of Subsequent Events for Audit of Financial Statements
Dual Dating When a subsequent event is recorded or disclosed in the financial statements after sufficient, appropriate audit evidence has been obtained but before the issuance of the financial statements, the auditor considers the following options for dating of the auditor’s report: (1) “Dual date” the report (original date of report plus date of subsequent event—limits liability so almost always this is what the CPA firm does) (2) Change the date of the auditor’s report to the date of the subsequent event—extends liability
Audit Procedures to Look for Subsequent Events Inquire of Management
Read Minutes of Meetings
Examples of audit procedures Read Interim Financial Statements
Inquire of Legal Counsel
Examine the Books of Original Entry
Review of Subsequent Events for Audit of Internal Control over Financial Reporting Auditors of public companies with $75,000,000 market cap must report on any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor’s report.
Internal audit reports
Independent auditor reports of reportable conditions Regulatory agency reports on ICFR
Information obtained from audit of ICFR 17-12
Final Evidential Evaluation Processes
Perform final analytical procedures.
Obtain a representation letter.
Review working papers.
Assess final audit results.
Evaluate financial statement presentation and disclosure.
Obtain an independent review of the engagement.
Evaluate entity’s ability to continue as a going concern.
The AICPA’s requirement is SQCS 10.38 The PCAOB’s requirement is AS No. 7
Estimating Likely Misstatements
Archiving and Retention Sarbanes-Oxley Act and PCAOB’s Documentation Standard (note that SAS 103 is similar but a bit less stringent):
• Require audit firms to archive their public-company audit files for retention within 45 days following the time the auditor grants permission to use the auditor’s report in connection with the issuance of the company’s financial statements.
• Require audit firms to retain audit documentation for 7 years (5 years if a privately held company and thus governed by SAS 103) from the date of completion of the engagement, as indicated by the date of the auditor’s report, unless a longer period of time is required by law.
• Require audit firms to retain all documents that “form the basis of the audit or review.”
• Require audit firms to include in the audit file for significant matters any document created, sent, or received, including documents that are inconsistent with a final conclusion. Significant changes in audit plans or conclusions must also be documented. 17-15
Going Concern Considerations
Going Concern Considerations
Communications to the Audit Committee
Communications to the Audit Committee (cont.)
In addition to the communications noted on the previous slide, some re internal control are required If public company with $75,000,000 market cap, as we noted in Ch. 7, AS 7 says significant deficiencies must be communicated to the audit committee If private (or small public) company, the auditor does not have to look for IC problems (other than for the purpose of performing an effective audit of the financials). However, SAS 115 says the auditor, if he learns of them, must communicate both material weaknesses and significant deficiencies to the audit committee (if there is no audit committee, then to others “charged with governance).” Also, auditor must communicate all this to management.
Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report Notify the company that the auditor’s report must no longer be associated with the financial statements.
If a private company, notify persons known to the auditor to be relying on the financial statements (e.g. banks, other creditors).
If a public company, make sure the SEC is notified that the auditor’s report and the financial statements can no longer be relied upon.
End of Chapter 17